A debt service fund holds monies to pay interest, principal, and other fees associated with short- and long-term debt. Some entities may be required to establish such funds before they can take on debt obligations. In other instances, they can be part of a financial plan to ensure that an organization maintains sufficient funds to handle the costs of debt over time. Public agencies and openly traded companies need to provide information about debt servicing activity to members of the public on request, including documentation on such funds and how their balances are used.
Government agencies are one example of an entity that may be required to create a debt service fund. If they want to issue bonds and other debts, they need to provide proof to the taxpayers that they can manage the debt. The fund includes a starting deposit, and is periodically updated with new deposits to cover the costs associated with maintaining debt. These deposits are carefully scheduled to ensure that enough money will be available when payments go out.
In other cases, such funds can be sound fiscal practice, but not required. Having a debt service fund can help companies and agencies demonstrate that they are ready to meet their financial obligations, and have the ability to do so. The size of the fund can depend on the type of debt held and what kind of debt the entity wants to take on. Deposits also need to be carefully timed for full coverage, to reduce the risk of not being able to make payments.
The process of servicing debt can be complex. For convenience, a debt service fund may have several accounts. These can be designated to cover specific obligations, like particular bonds or loans.
They can also be divided into principal and interest. This can make it easier to track debts, payments, and expenses to ensure monies will be available to fund an entire obligation from start to finish. If debts can be paid off early using the balance and there is a benefit to doing so, this may be considered as an option for reducing overall debt.
Government agencies, corporations, and other entities are most likely to use a debt service fund. In household budgeting, similar funds can be established, and people may use them in similar ways. For example, many banks allow people to make mortgage payments automatically out of a designated account, which people can treat like a debt service fund if this helps them organize and manage their finances.